Types of Irrevocable Trusts – Good Idea or Not?
There are many types of irrevocable trusts that can help you secure your assets and reduce taxes. Is it a good idea? They include the following:
- Asset Protection Trust An asset protection trust is used as a fortress to keep creditors from seizing assets. There are asset protection trust laws in states such as Nevada, Wyoming, Delaware, Alaska and North Dakota. In practice, we have found that they can provide a fair level of protection, especially, for residents of those states. However, they have the disadvantage of being under US court jurisdiction. Judge’s do not always follow the law and there are ever-expanding legal theories of liability. So, we have seen assets in domestic trusts seized on numerous occasions. Offshore irrevocable trusts in jurisdictions such as the Cook Islands and Nevis have a perfect or near-perfect track record for protecting assets from judgment creditors. Because US judges do not have jurisdiction over foreign trustees, the trustee need not comply with US court orders.
- Bypass Trust This type of trust that married people use. When one spouse dies, the property goes into the trust. The surviving spouse can use the property, but does not own it. This means that it is not part of the estate when the surviving spouse dies. This equates to tax savings.
- QTIP Trust Another trust designed for married couples, a QTIP trust typically provides income to the surviving spouse when one spouse dies. When the second spouse dies, other named beneficiaries receive the assets. This is typically the settlor’s children. QTIP stands for Qualified Terminable Interest Property.
- QDOT Trust A QDOT trust is similar to a QTIP trust. The difference is that noncitizens use it. QDOT stands for Qualified Domestic Trust.
- Life Insurance Trust With this type of trust, the trust is both the owner and the beneficiary of the life insurance policy. Anyone, in turn, can be the beneficiary of the trust. The grantor must typically create the trust at least three years before death. It lets a person reduce or eliminate estate taxes so more of the proceeds go to the beneficiaries. The trustee, then, administers insurance proceeds for one or more beneficiaries.
- Generation-Skipping Trust Wealthy families often use this tool. As the name implies, the trust skips a generation. The final beneficiaries are the grandchildren instead of the children. The children are beneficiaries of the income, but do not own the property. This means that when the children die, their trust property is not subject to estate tax. However, a generation skipping transfer tax may apply.
- Charitable Trust If you don’t have any family – or maybe you do have family but don’t want to give them an inheritance – you can opt for a charitable trust. If you are not married and have no children this may be a good choice. This type of irrevocable trust allows you to give gifts to charity as a way to lower income and estate taxes. The charity benefits from your donation as well, so it’s advantageous to both parties. There are three types of charitable trusts.
- More information and examples of irrevocable trusts can be found here.
Types of Charitable Trusts
- Pooled income trust: This trust allows you to pool your money with other grantors and receive income for a specified amount of time. For these trusts, the charity is the trustee and beneficiary.
- Charitable lead trust: You put property into a trust. Next, you name a charity to receive income from the trust for a certain amount of time. However, you name someone else as the final beneficiary.
- Charitable remainder trust: You put property into a trust. Then, you can receive a tax deduction for putting the asset into the trust. You name someone to receive income from the trust for a certain amount of time. The trust specifies a charity as the final beneficiary.
Trusts for Special Needs
If your goal is to protect assets and income for loved ones, choose one of these trusts:
- Special Needs Trust If you have a child or other loved one with special needs, a special needs trust can help provide financial support for this person in the event of your death. Property – particularly money – is placed into this irrevocable trust. You appoint a trustee to distribute the funds to buy necessities for the disabled person. The beneficiary never owns the property. This works to his or her advantage because the money is not considered as asset. The beneficiary does not make too much income and therefore can still qualify for government benefits.
- Spendthrift Trust Maybe you don’t have a disabled relative, but maybe you have a sibling or child who is horrible with money. Some people are just irresponsible with money, but that doesn’t mean that you need to leave them out of your inheritance. With a spendthrift trust, you can protect and control the money that you gift to family members who have trouble managing their finances. The settlor places assets into a trust. A trustee doles them out based on the terms in the trust. For example, you may allow the beneficiary to receive only a certain amount per week or month. The beneficiary cannot access the trust property, so the assets are protected from creditors. However, once the beneficiary receives money or assets, they become fair game.
Irrevocable Trust – The Way to Go?
Irrevocable trusts offer many asset protection, estate planning and tax advantages. For the general public, an irrevocable trust may be very useful in protecting assets from lawsuits, securing financial help for a special needs child or providing for children after the death of the parents.
You need to be able to trust your trustee. What happens if you have a falling out with your trustee? Change them. The beneficiaries can simply vote in a new trustee. The trustee must not be you. The trustee also must not be someone up or down the family tree, cannot be a controlled employee and cannot be an agent of yours. If any of these parties were trustees it would lose its asset protection advantages because the courts would consider these people your alter ego.
Should you choose an irrevocable trust, some wise advice is to have it skillfully drafted by an experienced professional. This is extremely important, since a poorly worded document may not do what you intended for it to do and ruin your asset protection and estate planning goals. Contact an estate planning expert to see if an irrevocable trust will meet your needs based on your unique situation. For more detailed information there is an article entitled Irrevocable Trust Miscellaneous Provisions that discusses the requirements in greater detail.
Linsay Thomas, Technical Editor, contributing author